Dollar Firm as Trade War Intensifies

March 12, 2025

Win Thin

U.S. tariffs went into effect at midnight; retaliation was immediate; January JOLTS data point to a still-healthy labor market; February CPI data will be the highlight; BOC is expected to cut rates 25 bp to 2.75%; Brazil reports February IPCA inflation
Lagarde warned that two-sided shocks make the ECB’s job much harder; the ECB will update its wage tracker; Poland is expected to keep rates steady at 5.75%
BOJ Governor Ueda did not sound worried about rising JGB yields; reports suggest Japan’s GPIF plans to maintain its current portfolio composition; Japan Q1 BSI survey weakened

The dollar has firmed as the trade wars begin in earnest. 25% tariffs on all steel and aluminum imports into the U.S. went into effect at midnight. DXY is trading higher near 103.605 after testing the November 5 low near 103.373 yesterday. The yen is underperforming on reports that GPIF will maintain its current portfolio composition (see below), with USD/JPY trading higher near 148.75. The euro is trading lower near $1.09 after the EU announced retaliatory measures (see below), while sterling is trading lower near $1.2935. Recent softness in the U.S. data continues to weigh on the greenback. We are not ready to push the panic button yet but if the data continue to soften, the strong USD fundamentals of strong growth, elevated inflation, and a more hawkish Fed will come into question. The dollar is finally getting some traction today as the prospects of higher inflation from tariffs is likely to keep the Fed on hold. Today’s CPI data may provide a good reminder to the markets that the Fed has a dual mandate.

AMERICAS

U.S. tariffs went into effect at midnight. The 25% tariff on all steel and aluminum imports into the U.S. went into effect. President Trump first doubled the tariff on Canadian steel and aluminum to 50% but then reversed course and moved back to 25% after Ontario halted its plan to put a surcharge on electricity sent to the U.S. Last Friday, President Trump also warned that reciprocal tariffs on Canadian lumber and dairy products could come at any time rather than the April 2 data that’s been put forth.

Retaliation was immediate. The European Union announced a two-stage retaliation covering EUR26 bln worth of U.S. goods. The EU will begin consultations with member states regarding which agricultural and industrial goods will be targeted by mid-April, which allows for a small window for negotiations. Of note, Australia failed to get an exemption from the steel and aluminum tariffs but has not yet announced any retaliatory measures. Elsewhere, U.K. official said “We’re not going to retaliate immediately in that way” but added that it would “reserve our right to retaliate” if needed. Despite the back and forth, tariffs are here to stay, with more coming at a very unpredictable rate. This will make the Fed’s job that much harder.

January JOLTS data point to a still-healthy labor market. Job openings unexpectedly increased to 7.740 mln vs. 7.600 mln expected and a revised 7.508 mln (was 7.6000 mln) in December. The job openings rate rose a tick to 4.6%, above the 4.5% threshold where a sharp rise in the unemployment rate becomes likely. The layoffs rate fell a tick to 1.0%, signaling there is not yet a layoff spiral underway, while the hiring rate was steady at 3.4%, in line with labor demand coming into better balance with supply. Of note, layoffs do not yet reflect the recent impact of the Department of Government Efficiency (DOGE) job cuts. Bottom line: the U.S. labor market remains in good shape, suggesting the risk of a recession is low. Nevertheless, the growth outlook advantage has shifted away from the U.S. to other advanced economies. This change is a cyclical drag on USD.

February CPI data will be the highlight. Headline is expected at 2.9% y/y vs. 3.0% in January, while core CPI is expected at 3.2% y/y vs. 3.3% in January. The Cleveland Fed’s Nowcast model forecasts headline and core at 2.8% y/y and 3.2% y/y, respectively. Watch out for super core (core services less housing), a key measure of underlying inflation. In January, super core increased 0.8% m/m vs. 0.2% in December, the biggest monthly rise in a year that kept the y/y rate stuck at 4.0%. Looking ahead to March, the Cleveland Fed’s model forecasts headline and core at 2.5% and 3.0%, respectively.

Bank of Canada is expected to cut rates 25 bp to 2.75%. However, the analyst community is split as nearly a quarter that were surveyed by Bloomberg look for no change. We had expected the BOC to pause easing in March because core inflation (average of trim and median CPI) is tracking above the BOC’s Q1 projection of 2.5%. However, Canada’s poor February labor market report and the drag to growth from tariffs uncertainty both leave plenty of room for the BOC to deliver a rate cut today. The BOC’s next Monetary Policy Report with updated forecasts is due in April, when 2027 will be added to the forecast horizon. The swaps market is pricing in 75 bp of total easing over the next 12 months.

Brazil reports February IPCA inflation data. Headline is expected at 5.06% y/y vs. 4.56% in January. If so, it would be the first acceleration since November to the highest since September 2023 and above the 1.5-4.5% target range. At the last policy meeting January 29, the central bank hiked rates 100 bp for the second straight time to 13.25% and said a similar hike would be seen at the next meeting March 19. Looking ahead, the swaps market is pricing in 175 bp of total tightening over the next six months that would see the policy rate peak near 15.0%.

EUROPE/MIDDLE EAST/AFRICA

President Lagarde warned that two-sided shocks make the ECB’s job much harder. She noted that “Trade fragmentation and higher defense spending in a capacity-constrained sector could in principle push up inflation. Yet US tariffs could also lower demand for EU exports and redirect excess capacity from China into Europe, which could push inflation down.” We concur, and that is the dilemma that most central banks face this year. The market sees only 40% odds of a 25 bp cut at the April 17 meeting. Looking ahead, the swaps market is still pricing in nearly 75 bp of easing over the next 12 months. Escriva, Centeno, Nagel, Lane, and Panetta all speak later today.

The ECB will update its wage tracker. The wage tracker currently points to negotiated wage pressures easing to 3.2% in 2025 compared with 4.7% in 2024. The wage tracker with unsmoothed one-off payments (like the one used for the ECB’s indicator of negotiated wage growth) points to wage growth easing to 2.8% y/y in Q4 2025 vs. the 6.5% peak seen in Q3 2024. Overall, the eurozone disinflationary process remains well on track.

National Bank of Poland is expected to keep rates steady at 5.75%. Minutes to the February 5 meeting will be published Friday. At that meeting, the bank kept rates steady and reiterated that “in the coming quarters inflation will remain markedly above the NBP inflation target.” Governor Glapinski said he saw no grounds to change interest rates now as inflation is forecast to be around 5% in H1. Despite the hawkish comments, the swaps market is pricing in 75 bp of easing over the next 12 months. This looks optimistic considering given the inflation trajectory. Poland reports February CPI data Friday. Headline is expected to remain steady at 5.3% y/y. If so, it would remain at the highest since December 2023 and well above the 1.5-3.5% target range.

ASIA

Bank of Japan Governor Ueda did not sound worried about rising JGB yields. The 20-year yield is trading at the highest since 2008, while the 30-year yield is trading at the highest since 2006. Yet Ueda said “My understanding is that the rising trend since last year reflects the market’s views on the economy and inflation, or shifts in interest rates overseas. There is no major gap between our views and the market’s.” He added that “One of the biggest factors driving long-term yields is market expectations regarding the outlook for short-term rates. It’s natural for the yields to move by reflecting those views.” The comments come ahead of the BOJ meeting next week, where a hold is widely expected.

Reports suggest Japan’s Government Pension Investment Fund (GPIF) plans to maintain its current portfolio composition. There was speculation in recent months that the JPY260 trln GPIF would increase its allocation to domestic stocks and bonds, which could help explain the kneejerk downside reaction in JPY following the Nikkei report. Instead, the Nikkei report suggest it will continue investing 25% each in domestic and foreign stocks and bonds for five more years from FY2025. GPIF will announce its asset allocation plan on March 31.

Japan Q1 BSI (Business Sentiment Index) survey weakened q/q. Large industry came in at 2.0 vs. 5.7 in Q4, while large manufacturing came in at -2.4 vs. 6.3 in Q4. Large non-manufacturing came in at 4.1 vs. 5.4 in Q4. It appears that BSI has peaked. However, the index is not a very reliable bellwether indicator of real GDP. The Tankan report, due April 1, is better.

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